Based on Bitcoin, the Dow may be due a 30% correction…

As two of the United States of America’s main general stock indices go parabolic, The Dow Jones Industrial Average and The Standard and Poor’s 500, Wall Street veteran trader Mark Minervini is sounding a warning.

He tweeted on Monday: ”The Dow’s parabolic upturn suggests this is turning into a FOMO market (fear of missing out) as investors chase price.”

I think that’s a shrewd observation. Click on the links I’ve added above and you’ll go to the Google charts for these indices. Set the time period to ‘maximum’ and you’ll see the parabolic effect. It’s clear that these prices have moved well up and away from the 200-day moving average price, and that’s worrying.

Minervini went on to tweet: “Parabolic uptrends usually do not correct with shallow pullbacks, when they are broken. Bitcoin recently broke its parabolic uptrend.”

Bitcoin’s near-vertical plunge

He’s using Bitcoin as a model to suggest what may happen next for the Dow. As I write, the extent of Bitcoin’s correction from its highs has been around 50%. However to me, the underlying investment represented on a Bitcoin chart is devoid of meaningful fundamentals. The price broke free from any association with underlying value ages ago. Bitcoin has been, and still is, in a bubble, fuelled by speculation and gambling.

The Dow Jones and the S&P 500, on the other hand, are indices made up of the share prices of some of America’s largest companies. Backing each company’s share price within each index is a real company with a real business, and valuations will relate to the underlying fundamentals of those businesses even if prices have moved ahead of themselves.

That said, the Dow and the S&P could easily correct 30% just to get back to their ‘natural’ uptrends. Bitcoin, meanwhile, enjoys no support from fundamentals, so I’m expecting it and other cryptocurrencies to crash much further down at some point.

London will likely follow Wall Street

What will happen if the Dow and S&P 500 do correct by as much as 30%? There’s a long history of the UK stock market following big moves like that from across the pond. So if we see a big market correction in the States as Mark Minervini thinks likely, we’ll see a big correction in the main FTSE 100 and other indices here with most stocks in most investors’ portfolios going down.

Maybe you are seeing weakness in your portfolio already. There’s been a long bull run in growth stocks and some outperforming names are now trading at frothy valuations. I’ve noticed that the slightest scent of mediocre operational performance has been punished lately with often brutal share price reversals. I think that’s another warning sign that a general, market-wide correction could be on the way.

Long-term investors shouldn’t worry too much about all this as a decent correction can throw up opportunities to buy shares with good quality underlying businesses, or index-tracking funds, at fairer valuations, which is a strategy that could pay off in the long run. 

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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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